The Basics of VAT Revisited
It’s been some years since we last looked at the basics of Value Added Tax (or VAT for short) so we thought that a recap would be useful for businesses that may not have had to deal with it previously.
VAT is a system that taxes what people spend and is administered by HMRC. The consumer pays VAT on the item that they buy, but businesses act as agents for collecting the VAT paid by the consumer.
Did you know? - A common misconception is that VAT collected is the business’s money because it is paid into the business bank account. It isn’t. You act as an agent for HMRC and collect it on their behalf.
This is one of the reasons governments around the world love VAT!
A good practice is for businesses to manage revenue rather than cash flow in the profit and loss account because revenue does not include the VAT collected, but the cash in the bank does.
We recommend that you save the VAT collected in a separate bank account to avoid the temptation to use it for business purposes. HMRC will want it!
Who Needs to Register for VAT?
When you are just starting your business, you will not necessarily need to register for VAT. You only need to register for VAT when your turnover goes over £90,000 in a rolling 12-month period. You should register when you think your turnover will exceed the £90,000 threshold in the next 30 days.
There are 3 rates of VAT.
Standard VAT rate of 20%
Reduced rate of 5%
And Zero-rated 0%
VAT-exempt goods and services include:
Financial services, investments and insurance
Garages, parking spaces and houseboat moorings
Property, land and buildings
Education and training
Healthcare and medical treatment
Funeral plans, burial or cremation services
Charity events
Antiques
Gambling or lottery tickets
Sports activities
If you sell goods and services that are exempt from VAT, then you don’t charge any VAT on these goods and services, nor can you recover any VAT you have paid on your supplies. This is referred to as supply rules.
How do I Apply For VAT?
You can register for VAT online, and you will receive your VAT number through the post. The letter will include additional details such as when you need to submit a VAT return when you need to make a payment and what your VAT number is.
The effective date of registration is also on this letter. Until you get this letter, do not charge VAT or show VAT on your invoices. You can, however, start to change your pricing structure to accommodate the coming changes.
Remember: Once you’re VAT registered, if you don’t increase your prices, you’ll be making 20% less than before registration. You may therefore wish to adjust your prices and it’s a good idea to let your customers know why this is happening!
Cancelling your VAT registration
If your taxable turnover goes below £88 000 and you were registered for VAT but don’t want to be registered anymore, you can de-register for VAT. You have to de-register if you cease to trade (so don’t generate any further turnover) and if you sell your business.
VAT Information on Invoices
There is a lot of mandatory information that needs to be on the VAT invoice that you issue to your customers:
The date of issue.
Sequential number that is unique to that invoice.
Your VAT number.
The full name and address of both the businesses and the customer.
A description of the quantity and description of the goods and services supplied.
The gross amount payable excludes VAT.
The rate of VAT charged.
The amount of VAT payable.
If you are VAT registered, you must:
Give your customers a VAT invoice for all goods and services delivered.
Keep a copy of the VAT invoice (and make sure you can find it!)
Keep proper accounting records
Keep the accounting and business records for 6 years.
Have a system of how you calculate the VAT owing to HMRC for each VAT period.
Submit your VAT returns on time.
Make your VAT payments on time.
The amount you pay to HMRC for VAT (or get refunded) is the difference between the VAT outputs and VAT inputs. Outputs is the VAT on sales and turnover. Inputs are the VAT on things you have paid for i.e., accounting services.
There are different VAT schemes for retailers:
Normal: This is the default VAT scheme if you haven’t selected any other scheme and the VAT outputs and inputs are calculated on the date of the invoice to your customers and when you receive the invoice from your suppliers. The normal VAT rates apply here.
Special Schemes for retailers: The reason you have these special schemes is that retailers sometimes sell a combination of 20%, 5% and 0% of supplies but don’t necessarily know instantly how much of each they have sold. You calculate the input VAT based on a VAT fraction, but this needs to be approved by HMRC first.
Cash: You account for VAT on your outputs when you are paid by your customers rather than by the invoice date. Also, you claim the input VAT on expenses when you pay for them. Your business is eligible to use this scheme if your turnover is less than 1.35 million for the next 12 months and you are up to date with your VAT returns and payments.
Flat Rate Scheme: This scheme is open to small businesses with a turnover of less than £150,000 excluding VAT. This is a good scheme for businesses that don’t want to spend too much time calculating their VAT each month.
In this scheme, VAT is still charged to customers at 20%, but what you pay to HMRC depends on what flat scheme rate you have registered/applied for with HMRC. Different industries have different rates, and usually, industries that don’t have a lot of input claims have a higher flat scheme rate, i.e., accounting services.
If you need help with setting up VAT or other tax affairs, get in touch!